Tuesday, 29 May 2012

What if Ireland voted no to the Treaty

On
Thursday Ireland votes on the Fiscal
Stability Treaty. Polls suggest the result will be yes. Will this be a solid
endorsement for the clauses of the Treaty, and the vision that lies behind it?
I doubt it very much. What may be much more decisive is a clause that only allows
access to Europe's new bailout fund to states that ratify the treaty.Given Ireland’s current situation, you
could say that voters have very little choice but to vote yes. In addition, I
have read quite a few posts over the past few weeks (e.g. John McHale here)
suggesting that the Treaty does not impose any additional burdens to the
austerity Ireland is already implementing. In that sense, there is no immediate
cost in voting yes, if you think the current austerity is unavoidable.

If that is the immediate cost
benefit calculus, what about the longer term? Philip Lane writes
“My own take is that, if the Treaty is implemented in an intelligent,
cyclically-sensitive manner (consistent with the flexible, holistic
interpretation laid out in the “six pack” regulations), the new fiscal
framework will be a positive force, helping Ireland and other European
countries to gradually exit from high debt levels and avoid destabilising
pro-cyclical fiscal policies in the future.”

Unfortunately,
I think you could also argue exactly the opposite. If the Treaty is implemented
in an unintelligent manner, with an attempt to satisfy all its numerous rules
and clauses without regard to macroeconomic context, the results could be
disastrous. (If you want an example of how this can happen, see
the Netherlands.) As I have suggested before,
the Treaty is similar to the Stability and Growth Pact (SGP). True, compared to
the original SGP, the emphasis on cyclically adjusted deficits gives formal acknowledgement
of the importance of automatic stabilisers. More generally, whereas in the
original Pact there were two main criteria for budget deficits, now there are many
more (see here, or here).
That can be read as flexibility, or it can be interpreted as confusion, muddle
and bad economics. Hence both optimistic views like Philip’s and more
pessimistic readings (see Karl Whelan here for example) are
possible.

What I
believe is clear is the overall vision that the Treaty represents. It sees the
essential problem with the Eurozone as being public sector indulgence. This is
a profound misreading of what happened before the recession. By far the bigger problem
for most periphery countries was private sector indulgence fuelled by cheap
borrowing. In Ireland, and now in Spain, this transforms itself into a public
sector problem because banks are bailed out.

The
fact that it was excess private sector borrowing that was the ultimate cause of
the crisis does not mean that fiscal policy was appropriate. Far from it.
Fiscal policy should have been much tighter than it was, because it needed to
be countercyclical. However, the idea of countercyclical fiscal policy was
nowhere to be found in the original SGP, and hardly figures in the Treaty. If
the Treaty had been a realistic response to the current crisis, issues to do
with macroeconomic stability (e.g. relative inflation rates, real exchange rate
disequilibrium) would be at its centre, rather than as the vaguely worded single
paragraph that is Article 9.

This
failure in both the original SGP and the new Treaty to recognise how important
countercyclical fiscal policy is to the viability of the Euro is a major,
perhaps the major, design flaw. (I have written about this before,
but for a similar message see here.)
What is worse, the obsession with public sector profligacy has diverted
Eurozone policymakers from understanding this, both before and during the crisis. It
has also discouraged recognising the scale of the problems facing the banking sector,
and indeed the obsession with austerity has probably
made this problem worse.

One
response to this argument is political. Yes, the Treaty is a distraction, but
it is a pre-requisite for other important reforms of the euro system. In
simple language, the Treaty is needed because without it there is no chance of
persuading Germany to even think about Eurobonds and the like. But perhaps what
has to change is this German (and Dutch, and Finnish) mindset. As long as the
‘fiscal irresponsibility’ story remains the dominant narrative, we will get
either continuing policy inertia, or worse still games
of chicken being played with national electorates. That road may lead to
disaster, as Boone and Johnson argue here.
There needs to be a collective realisation that the causes of the crisis are not
as originally advertised. There are solutions (e.g. Nick Stern here), but they require
Germany and others to put Euro survival ahead of national self interest. With
the election of Hollande, there is a chance of this happening. In this context
you could argue that an Irish yes vote does nothing to help change the
austerity mindset, whereas a no vote might have contributed to the mindset’s
demise.

That is
easy for me to write. It is also easy for me to conjecture from the other side
of the Irish Sea that if Ireland voted no, this would make no difference
to their ability to receive bail-out funds. Ireland has been the poster boy for
the ‘austerity’ cure, and for this and many other reasons the Eurozone is not
going to let the little matter of a popular referendum make them throw Ireland
to the market wolves. However, I can quite understand that, given what Ireland
has been through, it would not want to take that risk for what would, I admit, be
little more than a gesture. It may also be that, ironically, Ireland’s
opportunity to argue that the Treaty is a dangerous distraction is greater if
it votes yes. If the vote is yes, it must take that opportunity.

2 comments:

"As long as the ‘fiscal irresponsibility’ story remains the dominant narrative, we will get either continuing policy inertia, or worse [...]."The same is true of the euro. As long as its inherent flaws are not widely recognized, there isn't much chance that the possible solutions for its survival will be discussed and implemented.In any case, it is really doubtful that the eurozone countries will be able to reach an unanimous agreement.